Today we live in a very competitive environment. Only top businesses succeed to provide real value to customers and survive in the market. But how can we add more value than our competitors? Is it by having better marketing strategies? Is it by adding features our customers would love? These could be, depending on the product or service, some good ideas to differentiate and add more value to customers.
But then the next question comes: “Do we have enough budget to invest on marketing or R&D to enhance value?” Then, silence comes. This probably means that there is not enough budget to improve our current product or service, meaning that we are jeopardizing our survival in a given market.
If profit is low, it’s difficult to put aside some budget to continuously improve our offer. We operate in a survival mode where we often focus on increasing sales in a market that demands a better offer. However, this is not always possible and we remain stuck with our current offer.
But how can we create extra budget to finance product or service improvements? It may sound logic to say that increasing sales is the answer to more revenue, and therefore a bigger income to build marketing or R&D budget. But this is not the only way. We can also increase our revenue by reducing our costs. Actually, this approach can have a much bigger impact to the business profitability.
The graph below shows the necessary revenue increase needed vs the material costs decrease:
As shown, the lower the profit margin, the greater the impact of a cost reduction vs the necessary revenue increase. In other words, focusing on reducing your purchasing and operational costs will allow you to improve your profit in a much faster way.
Let me give you a practical example. You are selling each unit of your product for 4,8€ and your cost per unit is 4,3€. This means that you have a 0,5€ profit (12%) per product sold. See the illustration below:
This profit will allow us to survive in the market for a given time, but will not allow us to re-invest much in our business to become innovative and add more value to customers. Remember, that the sales unit price is a value given by the market that you are not able to increase at your own willingness. But let’s see what happens when we focus on reducing our costs:
As you can see, by bringing down the unit cost to 3,8€ the profit doubles and we generate extra cash that can be used for marketing or R&D investments. It may sound difficult to capture a 14% cost reduction per unit, but it is possible in most of the cases. Category strategies, volume bundling, supplier competition, elimination of inefficiencies or best practice benchmarks are examples on how we can achieve this.
This may even have a bigger impact in tough times where competition is high and market prices drop. If we focused our attention in capturing cost reductions we will be able to reduce the unit sale price and still be profitable. See the graph below:
Under this circumstance, we are able to respond and survive to a potential market crash. Others will be swiped away not being able to sell at that lower price. Remember that it’s not about reducing the quality or performance of your products, but about increasing your procurement skills and operational efficiency.
To conclude, have in mind that focusing in cost reductions is not just a one-time thing. We should strive to continuously improve our costs to be able to invest in out customer desires and survive when tough times come.